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In recent weeks, a number of newspapers have
reported on growing discontent among conservatives who charge that federal
spending in general — and domestic spending in particular — are growing at
explosive rates and that the President and Congress need to crack down on
domestic spending growth. The claims of dramatic spending growth have been
accepted at face value in a number of media venues.[1]

The claims, however, turn out to rest in large
part on dubious use of data that produces misleading conclusions (as is
explained in detail, starting on page 3). Careful examination of the budget
data, using standard methods of analysis employed by the Congressional
Budget Office, the Office of Management and
Budget, and other budget analysts and
economists, shows:

While federal spending has risen in the past few years, it
remains far below peak levels. The standard measure used to examine changes
in federal spending over extended periods of time is to measure spending as
a share of the economy. Federal spending equaled 19.9 percent of the
economy (i.e., of the Gross Domestic Product) in fiscal year 2003. This was
lower than in every year from 1975 through 1996.

Nearly two-thirds of the increase in spending in 2003 that has
resulted from actions that federal policymakers have taken since January
2001 occurred in the areas of defense, homeland security, and international
affairs (which includes expenditures in
Iraq and
Afghanistan).

Total appropriations for all discretionary programs —
including defense and homeland security programs — will rise 3.4 percent in
fiscal year 2004 before adjusting for inflation, and just 1.7 percent after
adjusting for inflation.

Congress and the White House have expanded several entitlement
programs, and the prescription drug legislation in particular ultimately
will have large costs. A sizeable share of the increases that policymakers
have enacted in entitlement spending other than the new prescription
drug benefit, however, are temporary increases made in response to
the weak economy — such as the provision of additional weeks of unemployment
benefits and fiscal relief to the states. These temporary spending
increases will end as the economy recovers; they pose no ongoing fiscal
threat.

In addition, reports that have sought to portray
recent growth in federal spending as out of control have missed two
fundamental points concerning the current fiscal environment. First, rates
of spending growth virtually always increase during economic downturns,
because more people lose their jobs and qualify for assistance. The
question is whether the recent rate of growth in federal spending outside
defense and homeland security is unusual for a recessionary period. The
answer is that it is not. The rate of growth over the past few years in
spending outside defense, homeland security, and international affairs is
virtually identical to the rate of growth during the last downturn, in the
early 1990s.

Second, the fiscal impact of the domestic
spending increases remains much smaller than the fiscal impact of the tax
cuts. Increases in domestic discretionary spending account for only three
percent of the increase in costs in fiscal year 2003 that resulted from
spending and tax legislation enacted since January 2001. Increases in
entitlement spending accounted for another 13 percent of the increase in
costs. By contrast, increases in defense, homeland security, and
international affairs spending accounted for 30 percent of the increase in
costs from legislation enacted since January 2001. And tax cuts accounted
for 55 percent of the cost of such legislation, a figure that will rise to
58 percent in 2004.

The Heritage Foundation
Reports

The figures just cited convey a very different
sense of domestic spending trends than the figures being cited by those on
the right who decry “runaway federal spending” and call for policymakers to
clamp down on “exploding” domestic spending. The claims regarding runaway
spending come to a large degree from a series of recent Heritage Foundation
reports by Brian Riedl. These reports portray federal spending, especially
for domestic programs, as out of control and imply that rising deficits are
due primarily to a lack of spending discipline. The pending omnibus
appropriations bill is singled out for particular criticism. These Heritage
reports are the source of a number of frequently cited “talking points,”
including:

Federal spending has risen so much that it exceeds $20,000 per
household for the first time since World War II;

The majority of the new spending since 2001 is unrelated to
defense or terrorism;

Spending unrelated to defense and the terrorist attacks grew
11 percent between 2001 and 2003, the fastest rate of growth in nearly a
decade; and

The omnibus appropriations bill (and the other fiscal year
2004 appropriations bills) are sufficiently bloated that discretionary
spending will jump another 9 percent in 2004.

These talking points — and the analyses that
underlie them — rest, however, on questionable uses of budget data that are
inconsistent with standard practices most budget analysts employ to avoid
producing misleading conclusions. There is no question that federal
spending has grown significantly in the past few years. But careful
analysis produces results at odds with the picture that Riedl’s reports
paint. The rest of this paper considers the weaknesses of the Heritage
reports and also provides findings from analysis that examines spending
growth using widely accepted budget measures.

1.Is Federal Spending at a Post-World War II High?
Riedl trumpets the finding that federal expenditures per household, after
adjustment for inflation, are at a post-World War II high. Budget analysts,
however, generally do not regard expenditures-per-household as a
particularly useful way to measure spending trends over long periods of
time. They strongly prefer to track federal spending over extended periods
as a share of the economy. When the Congressional Budget Office, the Office
of Management and Budget, and analysts and economists with no ax to grind
seek to assess changes in government spending and tax receipts over long
periods, they generally examine changes in spending as a share of the
economy, rather than changes in expenditures per household.

Analysts find much less value in examining
expenditures-per-household over time for two fundamental reasons. First,
the economy grows over time, and household incomes rise with it. As long as
federal spending does not increase as a share of the economy, it consumes no
greater share of the nation’s income, and no tax increases are needed to
finance it. Second, keeping federal spending from rising over long periods
of time as measured on a per-household basis — which Riedl implies is
the appropriate standard of fiscal discipline — is virtually impossible.
Federal expenditures per household rise over time due to such basic factors
as advances in technology in health care and other areas and real wage
growth in the U.S. economy.

Increases in federal expenditures over time in part reflect
improvements in technology. For example, major new health care technologies
have emerged in the decades since World War II — such as MRIs and drug
therapies — that markedly improve health and save lives but have
substantially increased the cost of health care. As a consequence, health
care costs have risen faster than inflation in both the public and the
private sectors, a trend that continues today as medical technology
continues to advance and new medical breakthroughs continue to occur. No
one would suggest that Medicare, Medicaid, and veterans health programs not
use these new and improved medical technologies.

Similarly, no one would suggest that our
military still use World War II or Korean War-vintage technologies.
The Air Force now flies B-2 Stealth bombers; the Navy uses nuclear-powered
submarines and launches long-range cruise missiles; and the Army operates
unmanned aerial vehicles equipped with air-to-surface missiles. These
newer technologies make our military more effective but cost more than the
weapons they replace.

Part of the increase in federal spending over time also
reflects real growth in wages across the
U.S. economy. The largest
single federal program — Social Security — is directly linked to wages.
Its benefits are designed to replace a certain percentage of wages that
workers earned during their careers so that their standard-of-living does
not fall too much in old age. Since average wages rise faster than
inflation as the economy grows, average Social Security benefits also rise
over time, as do the payroll taxes that finance them. Preventing
Social Security benefits from rising over time would require cuts in Social
Security benefits that would become increasingly deep as the years go by.

Moreover, the federal government is a large employer, and to
attract qualified workers, it must offer wages that compete with
private-sector wages for comparable positions. Freezing federal spending
per household over time in real terms would require the federal government
to freeze real wages for decades at a time. If real wages for federal
civilian and military personnel were frozen over time while wages in the
private sector continued to increase, the federal government — including the
Armed Forces — would not be able to attract or retain qualified personnel.

The flaw in Riedl’s approach is that it ignores
real economic growth and its effects on household budgets and the federal
budget. As the economy grows, household incomes rise. Indeed, income per
household, after adjusting for inflation, is three times higher today
than it was at the start of World War II. With higher incomes, both
households and the nation can afford more. Increases in federal spending
consequently do not pose a problem unless spending consistently rises faster
than the economy does.

The relevant question thus is not whether
federal expenditures per household are higher than in the previous 60 years
— which, of course, they are — but whether federal expenditures as a
share of the economy are at higher levels than in the past. And federal
spending as a share of the economy is not unusually high. Federal
spending in 2003 equaled 19.9 percent of GDP, lower than in every year from
1975 through 1996 (see the graph on page 1).

Moreover, federal spending as a share of GDP
necessarily rises when the economy weakens, since expenditures for programs
like unemployment insurance, Medicaid, and food stamps increase as workers
lose their jobs and qualify for these benefits. At 19.9 percent of GDP,
federal expenditures were higher in 2003 than in the immediately preceding
years, but substantiallylower than during the downturns of
the early 1990s and the early 1980s, when expenditures exceeded 22 percent
of GDP in most years and rose as high as 23.5 percent of GDP in 1983.

Heritage’s trumpeting of the factoid that
expenditures per household are at a post-World War II high would not be so
problematic if the Heritage reports also provided figures on changes over
time in federal spending as a share of the economy (and noted that the
latter measure is the more widely used method for examining changes over
long periods). Heritage never mentions the data on spending as a share of
the economy, however, or explains that those data yield a different result.

2.Are increases in
domestic spending responsible for a majority of the overall increase in
spending between 2001 and 2003?Riedl contends that
increases in domestic spending account for 55 percent of the total increases
in spending since 2001. He gets this result by bypassing the standard
method used to measure the size of increases and decreases in spending
caused by policymakers’ actions. Instead, he combines temporary increases
in expenditures for programs such as unemployment insurance that occur
automatically when the economy weakens, and other increases that occur for
reasons unrelated to policymakers’ actions (such as increases in health care
costs that affect the private and public sectors alike and increases in
Social Security costs that result from the rise in real wages over time),
with increases in costs that do result from legislation.

Analyzing the effects of actions that
policymakers have taken entails measuring changes from the Congressional
Budget Office baseline — that is, changes from the spending levels that
would have resulted if policymakers had passed no legislation to increase
spending in any way. When this approach — the standard method of
measuring spending changes resulting from policymakers’ actions — is used,
the results are sharply different from those that Riedl cites.

Increases in defense, homeland security, and international
affairs (including spending in
Iraq and
Afghanistan) account for 65
percent of the increase in spending in 2003 that resulted from legislation
enacted since January 2001.

Increases in domestic programs outside homeland security
(including increases in veterans benefits, which are part of domestic
spending) account for the remaining 35 percent of the spending increase.
(See Table 1.)

The Relative Fiscal Impacts of Tax Cuts and
Defense and Domestic Spending Increases

Moreover, when the costs of all
legislation enacted since January 2001 are examined — including the costs of
tax-cut legislation — the role of increases in domestic spending diminishes
further.

The Heritage reports are silent on the role of tax cuts in
contributing to the return of budget deficits, and conservative critiques of
exploding spending generally imply that spending increases are a major cause
of the resurgence of deficits but tax cuts are not. Yet CBO data show that
in fiscal year 2003, increases in domestic discretionary programs outside
homeland security accounted for only three percent of the cost of
legislation enacted since January 2001. Increases in entitlements enacted
since January 2001 accounting for another 13 percent of this cost.

Table 1

Cost in FY 2003 of
Spending Legislation Enacted Since January 2001

2003 Cost

(in billions of dollars)

Share of Spending Increase

Defense, homeland
security, and international

$104

65%

Domestic
discretionary (except homeland security)

$11

7%

Entitlement
legislation

$44

28%

Total Cost of
Spending Legislation

$159

100%

Note: Columns may not add due to
rounding. Figures include direct costs and associated increases
in the cost of interest payments on the debt.

By comparison, increases in spending for defense, homeland security, and
international affairs accounted for 30 percent of the cost of legislation
enacted during this period, more than the increases in domestic
discretionary programs and entitlement programs combined.

And tax cuts were responsible for 55 percent of the cost in
2003 of legislation enacted since January 2001, a percentage that will rise
to even higher levels in years after 2003. (See Table 2.)

3.Has Domestic Spending
Risen Unusually Fast in the Past Few Years? Another of Riedl’s
featured “talking points” is that spending unrelated to defense or the
terrorist attacks rose by a total of 11 percent between 2001 and 2003, the
fastest two-year growth rate in nearly a decade. This figure is accurate.
But the portrayal of domestic spending as experiencing mushrooming growth is
misleading, because it is presented without explanation that recessions
virtually always trigger a temporary increase in the rate of spending
growth.

Domestic spending rises during economic downturns because
expenditures for unemployment insurance and other benefit programs increase,
as people lose their jobs and employer-based health insurance and become
eligible for various benefit programs. Such increases in expenditures are
temporary in nature; they recede as unemployment declines.

Table 2

Cost in FY 2003 of All
Legislation Enacted Since January 2001

2003 Cost

(in billions of dollars)

Share of Total Cost

Tax cuts

$192

55%

Defense, homeland
security, and international

$104

30%

Domestic discretionary
(except homeland security)

$11

3%

Entitlement legislation

$44

13%

Total Cost of Legislation

$351

100%

Note: Columns may not add due to rounding.
Figures include direct costs and associated increases
in the cost of interest payments on the debt.

Moreover, these temporary spending increases are widely
regarded as beneficial, both because of the timely assistance they provide
to families that have lost their jobs and because these spending increases
provide effective economic stimulus and thereby help make recessions less
deep. For this reason, programs like unemployment insurance that
automatically expand when the economy weakens are known as “automatic
stabilizers.”

It thus should come as no surprise that rate of
growth in federal spending for domestic programs has been more rapid in the
past few years than in nearly a decade — after all, the previous economic
downturn occurred just about a decade before the current one. Instead of
making it appear shocking that domestic spending grew at a faster rate
during the past few years than during the preceding economic boom, as the
Heritage reports do, analysts might ask the following, more relevant
question: did domestic spending outside homeland security rise more rapidly
during the current economic slowdown than during the previous downturn, in
the early 1990s? The answer is that the rate of spending growth during the
recent downturn has not been more rapid.

Between fiscal year 2000, the
high point of the economic expansion of
the last decade, and fiscal year 2003, domestic spending outside homeland
security rose at annual average rate of 5.1 percent, after adjustment for
inflation.

Between fiscal year 1989 (the high point of the expansion of
the 1980s) and fiscal year 1992, such spending rose at the identical rate of
5.1 percent. (These figures exclude spending on interest payments.)

Spending Growth Should Slow in Next Few Years

Unemployment insurance expenditures will fall
sharply when unemployment returns to normal levels. Caseloads and
costs for other programs that respond to the business cycle, such as the
food stamp program, are expected to decline, as well. And federal fiscal
relief to the states will end.

The surge in discretionary spending also
appears to be receding. Growth in appropriations for discretionary programs
slowed considerably in 2003, and will slow much more in 2004. As discussed
below, total appropriations for discretionary programs — including defense
and homeland security — will increase only 1.7 percent over the 2003 level,
after adjusting for inflation, and appropriations for domestic discretionary
programs outside homeland security will only grow 1 percent from 2003 to
2004 in inflation adjusted terms. This is not a picture of domestic
discretionary spending that is shooting out of control.[2]

between fiscal year 2003 and fiscal year 2004.
Riedl includes no breakdown of domestic and defense spending increases in
his piece. Someone reading the piece in conjunction with Riedl’s earlier
reports would likely draw the conclusion that domestic and defense programs
alike are continuing to surge and are given another round of big increases
in the 2004 appropriations bills.

Table 3

Growth in Funding for
Annually Appropriated Programs

2002

2003

2004

Before adjusting
for inflation

Defense. Int’l,
Homeland

29.6%

15.5%

4.0%

Domestic
(outside homeland)

7.7%

5.1%

2.7%

After adjusting
for inflation, (i.e., in constant 2004 dollars)

Defense, Int’l, Homeland

27.9%

12.8%

2.2%

Domestic (outside homeland)

6.3%

2.7%

1.0%

Examination of the CBO data on the
appropriations bills shows that this is not the case.

Total appropriations for discretionary programs will rise only
3.4 percent in 2004; after adjusting for inflation, the increase is 1.7
percent. (These figures reflect adjustments to remove timing gimmicks that
otherwise can distort year-to-year comparisons.[3])

Funding for domestic appropriated programs outside homeland
security will increase by just 2.7 percent nominally in 2004, and 1 percent
after adjustment for inflation. (See Table 3.) The rate of real growth
this year in funding for domestic discretionary programs outside homeland
security is at its lowest level since 1996.

Since President Bush took office, the one year in which
domestic discretionary programs outside homeland security experienced rapid
growth was fiscal year 2002. The budget and appropriations bills for 2002
were written at a time when the White House and Congressional leaders were
issuing assurances that budget surpluses were so large that the nation could
readily afford large tax cuts, major defense spending increases, a
prescription drug benefit, and other initiatives, and still have large
surpluses left for decades, even excluding the surpluses in Social
Security. Once budget surpluses disappeared, real growth in funding for
domestic discretionary programs outside homeland security slowed to less
than one-third its 2002 rate.

More than 80 percent of the real increases in funding from
2002 to 2004 came in the defense, homeland security, and international
affairs areas (See Table 4.)

Table 4

Funding Levels for
Annually Appropriated Programs, After Adjustment for Inflation

(in billions of constant 2004 dollars)

2001

2002

2003

2004

Share of total Increase,

2001-2004

Defense
Int’l, Homeland

$362

$464

$523

$535

82%

Domestic
(outside homeland)

356

378

389

392

18%

Total

$718

$842

$912

$927

100%

May not add due to rounding

To portray the 2004 appropriations bills as
containing excessive spending increases, Riedl relies heavily on one
statistic — that outlays for discretionary programs (as distinguished from
funding — or appropriations — for such programs) will grow 9 percent in
2004. This 9-percent figure, which represents the increase in outlays
without any adjustment for inflation, is correct. But the reason that
outlays will increase 9 percent at a time when funding levels will rise by
only 3.4 percent is largely unrelated to the 2004 appropriations
legislation; the higher rate of increase in outlays is the result of funding
decisions made in prior years. In any year, as much as 40 percent of
outlays for discretionary programs are made from funds appropriated in past
years. This means that this year’s outlays reflect funding decisions made
both in this year and in years past. For example, funds appropriated for
the war in
Iraq in 2003 — such as funds to
replenish the military’s hardware — are still being spent this year. The
reason that outlays will grow faster than funding for this year is due to
more rapid growth of appropriations in prior years. Federal spending is
much like a ship. Although policymakers have begun applying the brakes to
appropriations, it will take time for the ship to slow substantially.

That outlays for discretionary programs will
increase 9 percent in fiscal year 2004 is relevant in other contexts. But
measuring changes in outlays is not a valid way to assess the degree of
profligacy in the 2004 appropriations bills.

Riedl’s report on the omnibus appropriations
bill also lacks information on the relative roles of defense and domestic
programs in contributing to the 9 percent increase in outlays that he cites.
The CBO figures do provide information on this matter; they show that 82
percent of the real increase in funding for discretionary programs in 2004
(i.e., the increase beyond the 2003 funding levels, adjusted for inflation)
consists of increases in the defense, homeland security, and international
affairs areas.

Conclusion

The conclusions that emerge from a fair reading
of the budget data, using standard budget measures, do not neatly fit the
claims being made on the right. There is no question that federal spending
has increased significantly in the past few years. But the spending growth
to date that has resulted from actions policymakers have taken in the past
few years has been concentrated primarily in the defense, homeland security,
and international affairs areas. Appropriations for domestic discretionary
programs outside homeland security have risen slowly since 2002, after
adjustment for inflation, and have not contributed much to the current
deficits. In addition, expenditures for entitlements such as unemployment
insurance will decline as the economic recovery strengthens. Tax cuts, by
contrast, have increased the deficit by a larger amount than all spending
increases combined.

This is not, however, a reason to be sanguine
about the fiscal outlook — to the contrary. If made permanent, the tax cuts
enacted over the last three years will cost the Treasury $3.3 trillion
including interest between 2002 and 2011, and defense, homeland security,
and international affairs programs will continue to absorb considerable new
resources even if their growth rates slow. In addition, the recently
enacted Medicare prescription drug bill will add substantially to deficits,
especially in future decades when its cost will expand. And of course, the
aging of the population and continued increases in health care costs will
have very large budgetary effects over time, especially as the baby boomers
retire. Deficits now extend as far as the eye can see and threaten
eventually to mount to dangerous levels.

End Notes:

[1]
This is a revised version of the paper released on
January 7, 2004. It
contains updated numbers based on CBO’s Budget and Economic Outlook
released on January 26th. We also now include the cleanup
and reconstruction of
New York City after 9-11 within the
category “defense, international, and homeland security.”